The 2.4% GDP growth figure reported for the second quarter caused many economists to once again be surprised about the state of the US economy. It seems that most had expected a higher number. Some had expected a much higher number. It is not clear what these economists use to form their expectations about growth, but it doesn't seem that they have been paying much attention to the economy. For those following the economy, a weak second quarter growth number was hardly a surprise.

As a basic way to assess growth, economists often separate out final demand growth from GDP growth. The difference between GDP growth and final demand growth is simply inventory accumulation. If the rate of inventory accumulation accelerates then GDP growth will exceed final demand growth. If the rate of inventory accumulation slows, then GDP growth will be less than the rate of final demand growth. If there is no change in the rate at which inventories are accumulating, then GDP growth will be equal to final demand growth.

The economy has been going through a classic inventory cycle in the last five quarters. Inventories had been shrinking rapidly in the second quarter of 2009. This is standard in a recession as firms look to dump a backlog of unsold goods. Inventories shrank less rapidly in the third quarter, which means they added to growth. Inventories started growing again in the fourth quarter, and growing rapidly in the first two quarters of 2010. Inventories added considerably to growth in these quarters, making GDP growth considerably more rapid and erratic than the growth of final demand.

The growth in final demand over the last four quarters has been very even and slow. It has averaged 1.2% over this period with a peak growth rate of 2.1% in the fourth quarter of 2009. Growth was just 1.3% in the most recent quarter.

The numbers of final demand should be of great interest since it is unlikely that inventories will provide any substantial boost to growth in future quarters. The second quarter rate of inventory accumulation was already quite fast, so future inventory figures are as likely to come in lower as higher. This means that GDP growth over the next few quarters is likely to be close to the rate of growth of final demand.

This should have policymakers very worried. There is no obvious reason that final demand growth will increase from the second quarter rate and several important factors that will push it lower.

The most obvious factor depressing growth will be the cutbacks by state and local governments that are trying to cope with huge budget shortfalls. A second factor is the winding down of the stimulus. Stimulus spending will stay near peak levels in the third quarter, but will start to wind down in the fourth quarter of 2010 and the first quarter of 2011.

Perhaps the biggest factor depressing growth will again be the housing market. A flurry of sales of homes due to the expiring tax credit helped boost GDP in the second quarter. While the sale price of an existing home is not counted in GDP, the fees associated with the sale are counted. The uptick in sales in the second quarter added 0.5 percentage points to GDP. The drop in sales will subtract at least this much from GDP in the third quarter.

More importantly, house prices are falling again, possibly at a rapid pace. This will convince homeowners that the bubble is not coming back and likely lead to a further decline in consumption. (The deficit hawks' pledges to cut social security and Medicare may also lead to lower consumption since they may convince people of the need to save more for retirement.)

In short, we are looking at a situation where the trend GDP growth rate going into the second half of 2010 is around 1.5%, with several factors likely to push it lower. This is a context in which the economy is likely to generate few if any jobs and almost certainly not enough jobs to bring down the rate of unemployment.

Getting the economy growing at a more rapid pace will require another round of stimulus from the government. This will require overcoming a massive amount of superstition, as well as pure political obstructionism. However, the first step is recognising that the economy is not on a healthy recovery path and that something needs to be done. The second quarter GDP report should be enormously helpful in convincing people that everything is not all right.